The Serenity Corporation distributes $200,000 in cash to its shareholder during 2018. Accumulated earnings and profits are $80,000 as of January 1, 2018. Current earnings and profits for 2018 are $84,000. Jonas, the sole shareholder of Serenity Corporation, has a basis of $48,000 in his stock. What is the tax effect of the distribution for Jonas?
A)Jonas will recognize ordinary income of $164,000 and a capital gain of $36,000.
B)Jonas will recognize ordinary income of $84,000, capital gain of $80,000 and a tax-free recovery of capital of $36,000.
C)Jonas will recognize ordinary income of $164,000 and a tax-free return of capital of $36,000.
D)Jonas will recognize ordinary income of $164,000 and a capital loss of $12,000.
E)Jonas will recognize ordinary income of $200,000 and a capital loss of $12,000.

Question

Quizplus · Accepted Answer

The distribution is first considered to come from current earnings and profits ($84,000), then from accumulated earnings and profits ($80,000), totaling $164,000 in ordinary income. The remaining $36,000 reduces Jonas's basis in the stock to $12,000, representing a tax-free return of capital, not a capital gain or loss.

The Serenity Corporation Distributes $200,000 in Cash to Its Shareholder